A pip in Forex refers to “point in percentage”, and is a popular way among Forex traders to express profits and losses. Understanding pips in Forex is vitally important to survive in the long-term, as they form the basis of any successful trading strategy. In this article, we’ll cover the definition of pips in Forex, how much is 1 pip in Forex worth and how to calculate profits and losses using pips with a few example.
What Does a Pip Mean in Forex Trading?
The price of a currency inside a currency pair is expressed by exchange rates. If you see that the EUR/USD (euro vs. US dollar) pair trades at 1.2040, this means that one euro costs $1.2040, or it takes $1.2040 to buy one euro. An exchange rate always shows the price of the base currency expressed in terms of the counter-currency, and the smallest increment that an exchange rate can change is called a pip.
In this regard, a pip is the fourth decimal place of an exchange rate. In our example above, if the EUR/USD exchange rate changes from 1.2040 to 1.2048, this would equal to a change of eight pips.
Similarly, if the exchange rate would fall from 1.2040 to 1.2035, this change would equal to five pips.
A Forex trader tries to anticipate the rise of fall of a currency pair, and profit from the change in the exchange rate. Naturally, as exchange rates change in pips, they’re the most popular way to express any profits or losses of a trade.
To determine the exact profit or loss, we need to know how much 1 pip in Forex is worth.
How Much is a Pip in Forex Worth?
A dollar-value of a pip depends on the currency pair that you trade and on the position size that you take. You can use the following formula to exactly determine the dollar-value of a pip.
If you open a trade on EUR/USD with a position size of 100,000 units (one standard lot), a the value of a single pip would equal to:
Now, let’s say your trade is 20 pips in profit. Your profit in dollar-terms would be equal to 20 pips x $8.31, which is $166.20. Similarly, if your trade would be 20 pips in loss, your loss would be $166.20.
What is a Pipette?
Until now, we’ve used the full form of pips in Forex. However, pips can also be expressed by pipettes, which are a fractal of a pip, i.e. 10 pipettes equal a pip. A pipette is the fifth decimal place of an exchange rate, and some brokers use this 5-digit approach to express exchange rates on their trading platforms. If this is the case, it’s important not to mix a pip and a pipette.
In our example above, if EUR/USD trades at 1.20407, the fifth decimal place represents a pipette. If the exchange rate rises to 1.20417, this would equal to a rise of 10 pipettes or 1 pip.
Forex Trading Pips Explained: How to Calculate Profits and Losses?
Perhaps the most interesting part about pips is how to calculate the exact amount of profit or loss on a trade. We’ll cover this with a few examples, using the formula mentioned above.
Example 1: A trade of 2 standard lots on EUR/USD is closed at 1.1850 with 35 pips in profit. What is the total profit of the trade?
Pip-Value = (0.0001 / 1.1850) x 200,000 = 16.88 EUR
35 pips x 16.88 EUR = 590 EUR in profit
Example 2: A trade of $50,000 on USD/JPY is closed at 110.25 with 22 pips in loss. What is the total loss of the trade?
Pip-Value = (0.01 / 110.25) x 50,000 = $4.54
22 pips x $4.54 = $99.88 in loss
Note that JPY-pairs have two decimal places, and a pip is the second decimal place in this case.
Example 3: A trade of 2 mini lots on GBP/USD is closed at 1.3645 with a 55 pips profit. Calculate the total profit of the trade.
Pip-Value = (0.0001 / 1.3645) x 20,000 = 1.47 GBP
55 pips x 1.47 GBP = 80.61 GBP in profit
In this article, we answered the question “What does a pip stand for in Forex?”. A pip in Forex refers to the smallest increment an exchange rate can change. A pip is usually the fourth decimal place of an exchange rate, but in pairs involving the Japanese yen, a pip reflects the second decimal place of the exchange rate.
It’s important to understand what’s the difference between a pip and a pipette, and how to calculate the value of a pip the correct way. If you get the basics right, you’ll have a much easier time adding more complicated concepts to your trading at a later stage. Those involve risk management, risk-per-trade and position sizing, to name a few.